Surreal cityscape symbolizing economic trends and demographics.

Decoding Economic Stability: How Demographics and Government Size Impact Your Wallet

Reese Marlowe in Business & Economy June 2025 • 4 min read.

"Uncover the surprising links between a nation's age, government spending, and its economic ups and downs – and what it means for your financial future."

Since the early 1980s, economists have been fascinated by the persistent reduction in business cycle volatility, a phenomenon dubbed the 'Great Moderation.' This period of relative calm has spurred extensive research into its underlying causes, with explanations ranging from advances in economic policy to shifts in structural factors within economies. Understanding these drivers is crucial for predicting and navigating future economic conditions.

Among the various factors explored, the size of government and the demographic composition of a nation's workforce have emerged as key areas of interest. The interplay between these elements can significantly influence economic stability, affecting everything from employment rates to investment returns. This article delves into these complex relationships, drawing on recent research to shed light on their impact.

This article aims to unpack the determinants of output volatility, focusing on the roles of demographics and government size in a panel of 22 OECD countries, using annual data from 1961 to 2014. By employing sophisticated econometric techniques, this analysis moves beyond ad hoc volatility estimates and accounts for potential non-stationarity, offering a more nuanced understanding of the forces shaping macroeconomic stability.

The Government's Role: Stabilizer or Source of Instability?

Surreal cityscape symbolizing economic trends and demographics.

The impact of government size on economic stability has been a subject of ongoing debate among economists. A seminal contribution by Gali (1994) investigated the effect of income taxation and government purchases on output volatility, finding that while both act as automatic stabilizers in the Keynesian sense, their net effect can be complex.

Further studies have emphasized that the stabilizing effect of government spending can vary over time and may be subject to nonlinearity, depending on the level of government expenditures (Crespo Cuaresma et al., 2011; Collard et al., 2017). Moreover, the composition of public finances, particularly the tax mix, matters for macroeconomic stability (Martinez-Mongay and Sekkat, 2005). Posch (2011) found that taxes on labor and corporate income tend to be stabilizing, while capital taxes can increase volatility.

Gali (1994): Government spending stabilizes economy.
Fátas and Mihov (2001): Fiscal policy is important.
Crespo Cuaresma et al. (2011): Depends on government expenditure.
Posch (2011): Certain tax mixes are useful for economy.

These findings suggest that the government's role in stabilizing the economy is not straightforward. While government spending and certain tax policies can act as automatic stabilizers, their effectiveness depends on various factors, including the level of government expenditures, the composition of public finances, and the specific type of taxes employed.

The Future of Economic Stability: A Balancing Act

Understanding the determinants of output volatility is crucial for policymakers seeking to promote economic stability. The findings presented here suggest that both demographics and government size play significant roles, with a larger share of prime-age workers associated with lower output volatility and higher public expenditure increasing volatility. However, the impact of government size is complex and depends on factors such as the tax mix and the level of government expenditures.

About this Article -

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This article is based on research published under:

DOI-LINK: 10.1111/obes.12286, Alternate LINK

Title: What Drives Output Volatility? The Role Of Demographics And Government Size Revisited

Subject: Statistics, Probability and Uncertainty

Journal: Oxford Bulletin of Economics and Statistics

Publisher: Wiley

Authors: Martin Iseringhausen, Hauke Vierke

Published: 2018-12-03

Everything You Need To Know

What is meant by the term 'Great Moderation,' and why is it important to understand it?

The 'Great Moderation' refers to the notable decrease in business cycle volatility observed since the early 1980s. Economists have explored various reasons for this phenomenon, including advancements in economic policies and changes in the structural components of economies. Understanding the drivers of the Great Moderation is essential for predicting and managing future economic conditions.

How did Gali (1994) characterize the influence of government spending on the economy, and what complexities arise when considering the size of government?

Gali (1994) demonstrated that government spending can function as an automatic stabilizer in the economy, aligning with Keynesian economic principles. However, the overall impact of government size on economic stability is more complex. Factors like the level of government expenditures and the composition of public finances, including the tax mix, can influence whether government size ultimately stabilizes or destabilizes the economy.

According to Posch (2011), how do different types of taxes impact economic volatility, and why is this distinction important?

According to Posch (2011), the type of taxes a government levies can have different effects on economic volatility. Taxes on labor and corporate income tend to stabilize the economy, while taxes on capital income may increase economic volatility. The composition of public finances, including the mix of taxes, is crucial for macroeconomic stability.

In general, how do demographics and government size influence economic stability?

Demographics and government size both play significant roles in shaping economic stability. A larger share of prime-age workers in a country is typically associated with lower output volatility, contributing to a more stable economy. Conversely, higher public expenditure tends to increase volatility. The interplay between these two factors is a critical consideration for policymakers aiming to foster economic stability.

What are some of the factors that can influence how government spending affects economic stability?

Several factors can affect how government spending influences economic stability. Crespo Cuaresma et al. (2011) and Collard et al. (2017) suggest that the stabilizing effect of government spending can change over time and might not be linear, depending on the level of expenditures. The specific tax mix, as noted by Martinez-Mongay and Sekkat (2005), also plays a role. Therefore, the effectiveness of government spending as a stabilizer depends on these varying conditions.